Hemlock for economic students
(Putting effective demand in the long run and prices of production together)

Thursday, August 11, 2011

Deep double dip thoughts

Okay, so it seems that more and more people think that we are in for a double dip. The Economist has said:

"the odds of a double dip over the coming year are uncomfortably high, perhaps as high as 50%."

Before you take them too seriously remember that they also say a few lines down that:

"the thoughtlessness of the debt deal—notably its failure to tackle any of the real sources of America’s fiscal problems, such as entitlement spending—raises a bigger worry."

As everybody knows that the fiscal problems result from the recession, Bush's tax cuts, and the two wars, they are just deliberately ignoring the truth, or worse, blissfully unaware of what's going on. The worry is not about the fiscal situation, and that is why markets have rushed to buy Treasuries in the middle of the crisis this week, after the S&P downgrade (Bob Kuttner got it right, those guys are just Triple-A idiots). I won't even talk about Ken Rogoff's argument (in the Financial Times) that "the biggest deficit is not in credit, but credibility" [is there a credibility fairy too?].

In truth, as noted (subscription required) by Joe Stiglitz in the Financial Times, at core this is a political crisis. Both in the US and in Europe the inability of the political elites to cope with the crisis, implies that fiscal stimulus (and in Europe not even low rates of interest on public debt for the periphery) is not in the horizon. In other words, more than a double dip, since the recovery was never really very strong, we'll remain in a limbo of stagnant growth in the center. Japan redux.

However, does that mean that we'll have another Lehman moment with a collapse of financial markets, and the collapse of trade, hurting the strong recovery in the periphery? That is less likely, but not an impossible scenario. Note that last time, the collapse in trade had significant impact in the economies of the periphery. This suggests that more mechanisms to maintain South-South trade going in case of a collapse of the financial system in the center might be a good idea.

PS: Dean Baker argues that the recent stock market panic is related to a possible Lehman moment coming from the on going European debt crisis.